Trading-Obligation Convergence Assessed

Shanny Basar

Clarus Financial Technology, the derivatives analytics provider, welcomed the significant convergence between European and US regulations which require certain derivatives to be traded on a venue.

The European Securities and Markets Authority published the final report for the trading obligation on 28 September, after a consultation period. The European Union regulator requires interest rate swaps in euros, sterling and US dollars to be traded on a regulated venue from the beginning of next year when the MiFID II regulations come into effect.

The US has required certain derivatives to be traded on swap execution facilities and be centrally cleared since 2013. Chris Barnes at Clarus Financial Technology said in a blog there has been significant convergence with swaps that are currently made available to trade (MAT), or required to be traded on a US swap execution facility. He noted there are just four swaps that do not have a dual trading obligation (euro 8-, 9- and 12-year plus US dollar 1-year MAC, or market agreed coupon, swaps).

“We are very happy to see a convergence of the European and American trading obligations,” added Barnes. “This simplifies market structure as well as setting a ‘gold standard’ internationally for other jurisdictions to aim for.”

He continued that eight-year and nine-year swaps versus six-month Euribor are the most noticeable difference between the two jurisdictions.

“I wonder if this new European Union trading obligation will motivate SEFs in the US to post new MAT filings to align the two jurisdictions? That strikes me as a good idea,” Barnes added.

In the consultation period for the EU trading obligation, market participants had warned that a lack of converge would create an  unequal playing field between jurisdictions and firms and fragment liquidity in a global market.

For example, Citadel had said in its response that the liquidity profile of an over-the-counter derivatives instrument does not drastically change based on geographical boundaries. Therefore, both US and EU market participants interact with the same core group of liquidity providers, and experience similar pricing and liquidity dynamics. In addition, trading venues in the US and EU are expected to gain equivalence so EU market participants will be able to access liquidity on US venues for satisfying the trading obligation and vice versa.

“As a result, we believe that Esma should only adopt a more narrow approach than the US trading obligation where it is absolutely clear that there is insufficient liquidity in a particular instrument,” said Citadel. “This will reduce regulatory arbitrage and ensure US and EU market participants are on a level playing field when transacting in the OTC derivatives market.”

However market participants have also warned that US and EU entities may not be able to transact certain derivatives in January if there is no decision on the equivalence of trading venues before MiFID II comes into force.

Emma Dwyer, partner at law firm Allen & Overy, spoke on a panel on cross-border harmonisation at the ISDA Annual Europe Conference in London last month. She said: “If there is not an equivalence decision before the start of MiFID II, then EU and US entities subject to the trading obligation will not be able to transact with one another except on a venue that is authorised by both jurisdictions.”

The European Commission has said it is aiming to announce an equivalence decision with the US in November.

Tracey Wingate, senior special counsel, international affairs at the Commodity Futures Trading Commission, the US regulator, was also on the panel. She said the downside is so tremendous that a political decision will be made before the end of this year. Wingate added: “It is like a game of chicken with two cars driving forwards towards each other and one swerves at the last minute.”

A poll at the ISDA conference found that 52% of the attendees expect an equivalence decision in 2018, after the start of MiFID II.

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